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What Is Rent To Own? Pros, Cons, and Answers

Buying a home can be a challenge for a lot of people. Between the credit score requirements, debt to income ratios, and down payment, it comes at no surprise that buying a home can feel like an uphill battle. If you’re looking to lay roots somewhere, but can’t meet the home buying requirements at the moment, you should consider finding a home that you can rent to own.

What is rent to own?

Renting to own is an agreement between the renter/buyer and the existing homeowner. Like renting, when you rent to own a home you and the landlord agree to the monthly rent charge, and the duration of the agreement before you move in.

The major difference between renting and a rent to own option is - you can buy the house at the end of the agreement. Additionally, some of the money you paid in rent will be taken off of the selling price of the home.

This is great for people who know they want to live in a specific neighborhood but can’t meet the requirements to buy a house yet. This will also provide quite a few benefits for the existing homeowner.

How Does Rent To Own Work?

Once you find the area of town you’d like to live in, there are various steps you’ll need to take to find and finalize a rent to own agreement. These steps include:

Rent To Own Agreement

The first step is to find a homeowner who will agree to a rent to own agreement. Some homeowners just want to sell their home and be done with it, and may not want to enter into a year or two agreement with an interested buyer. Other homeowners see the upside this can provide, and will be willing to entertain such agreement.

Once found, it’s time to iron out the agreements terms and conditions. This includes; what price you’ll pay in rent, the duration of the agreement, the option premium fee, and how much of your monthly rent will be deducted from the final purchase price of the home.

Appraisal And Home Inspection

Just like purchasing a home, you’ll need to schedule a home inspection and appraisal. This is designed to protect the renter. The home inspection should uncover anything wrong with the home (cracked foundation, leaky roof, work completed without permits, the age and condition of the furnace, hot water heater, or boiler, etc). The home appraisal is designed to provide a fair market value on the home, ultimately providing the buyer and seller with a fair number to agree upon.

Option Premium

The existing homeowner/landlord will require the renter to pay an option fee to even enter into this lease option. This fee is typically between 1 and 5% of the agreed upon final sale price. This fee is non-refundable in the event the renter backs out of the agreement and does not go through with purchasing the home.

Home Maintenance

Typically, as a renter, you live repair and maintenance free. If anything goes wrong with the home, the landlord is responsible for fixing it in a timely fashion. A leaky roof, a broken appliance, backed up plumbing, this all falls on the landlord.

That doesn’t apply to a rent to own agreement. These agreements are typically structured to put the repair and maintenance burden on the renter. After all, this protects the existing homeowner. Therefore, the landlord doesn’t end up ‘financing upgrades’ for the renter.

Avoid Late Payments

When you’re in a rent to own agreement, the renter has a lot of skin in the game. Many agreements have a clause stating ‘if the rent payment is late, the agreement can be voided, and the renter could lose any money they have already invested into the home’.

Additionally, paying bills on time builds/raises your credit score. You’re going to want to get the best mortgage possible, and that starts with having a higher credit score.

Shop Around For The Best Mortgage

As you approach the end of your renters agreement, it’s now time to start shopping around for a mortgage. A lot goes into finding the right mortgage. Like any major purchase, it’s good to get a few opinions/quotes before finalizing one.

Lease Purchase vs Lease Option

Be sure not to confuse a lease purchase with a lease option. These two are similar, but have distinct differences.

Lease Purchase

A lease purchase is an agreement that makes the renter legally obligated to buy the house at the end of the agreement.

Lease Option

A lease option gives the renter an option to buy the home at the end of the agreement, but not an obligation. In the event the renter chose not to buy the home, they could lose the money they’ve invested into it, but they wouldn’t face any legal consequences.

Buyer’s Point Of View: Pros And Cons

There are of course pros and cons to these agreements. Let’s review these below, starting with the buyers point of view.

Pros For Buyers

From a pros perspective, there are numerous reasons why a buyer would be interested in exploring this option.

  • Build A Downpayment: This allows the buyers to build a down payment. Perhaps, a buyer finds the right home, but at the wrong time, as they do not have enough money to meet their goal of down payment. If they entered a lease to own agreement, they could take a year or two to save more money for a town payment.
  • Lock In A Purchase Price: The purchase price is one of the first steps you’d iron out in the renters agreement. This is a huge benefit in a rising real estate market! If home prices rise, you’ll be thankful your price is locked in.
  • Build Equity Prior To Purchase: A portion of your rent will go to crediting the final sale price. The lower the final sale price is, the less you have to finance - meaning you will have a lower monthly mortgage payment.
  • Try Out The Home: This gives the homeowner an opportunity to get familiar with living with the home before it is actually theirs. If there was anything structurally wrong with the home, this would be discovered while you were renting the home and you could work with the landlord on the appropriate next steps.
  • Avoid Competition From Other Buyers: The basic rules of supply and demand apply to the real estate market. The more people that want to buy a home in a particular area leads to less homes being for sale resulting in the homes being priced higher. If you’re in a lease to own agreement, the current homeowner cannot entertain offers from other folks who are interested in buying their home.
  • Buy With Poor Credit: If you’re delaying purchasing a home due to a low credit score, a lease to own option may be suited for you. As you pay your payments on time, your credit score will rise, leading to more preferential mortgage rates when you’re ready to finalize.

Cons For Buyers

Despite the healthy list of benefits a lease to own agreement has, there are also some cons you must be aware of.

  • Potential Loss Of Up Front Premium Option: If you decide to back out of the deal, or you don’t qualify for a mortgage, you lose any capital you’ve invested into the contract or home.
  • Lack Of Control: You don’t technically own the house yet, so the landlord may be a bit restricting as to what you could do to the house. You may not be able to add your custom taste to the home until you officially own it, even if that means various home upgrades! Additionally, the landlord may take the rent money but not pay the mortgage, ultimately resulting in a loss of property.
  • Increased Rent: With the lease option, you’ll typically pay a premium on your rent. This could be 5-10%+ more then the current market value.
  • The Home’s Value Could Go Down: Real estate markets have ebbs and flows. Some years the value of a particular market or area will appreciate, whereas some years the market will lose value. Once you sign your lease to own agreement, you’re locked into the purchase price. This is a good thing if the market goes up, but a bad thing when the market goes down.
  • Maintenance Costs: Many lease option agreements are set up to have the renter responsible for the maintenance costs associated with the home. Maintenance can be expensive, and if you back out of the deal, you lose the money you invested to maintain the home.
  • Contract Is In Favor Of Seller: Between the increased rent expense, the potential to lose the money you invest into the home if you decide not to buy it, and the maintenance repair cost - it’s easy to see this agreement leans heavier in favor of the seller.

Seller’s Point Of View: Pros And Cons

Now let’s look at the other side of the fence, the sellers.

Pros For Sellers

For the most part, these lease options favor the seller. Some of the most talked about pros are:

  • Attract More Buyers: Whenever you’re selling your home, you want to cast as wide of a net as possible. If you offer the lease option, customers who may not be ready to buy your home in the present day may still be interested in leasing so they can purchase your home in the future. This will get more eyeballs on your home.
  • Sell For Higher Price: Flexibility comes at a premium. You may be able to charge a bit more for your home considering you’re offering flexibility to potential buyers. Add this to the profit you keep on the rent markup and you can quickly see how this becomes a profitable option.
  • Your Renter Is Invested: A concern many landlords have whenever they rent their home to a potential renter is - will they take care of the property? In a lease option, the renter is invested into the property just as much as the homeowner. They’ll be sure to take care of them home as if it was their own, as after all, it eventually will be.

Cons For Sellers

These pros don’t come without a few risks. Some sellers find the upside potential lucrative enough to offset the risk exposure, but nonetheless, these risks are still worth noting and being mindful of.

  • Renter May Not Purchase: Although you’d be able to keep additional profit, it’s a huge inconvenience if the renter does not purchase the home. This could hold up your plans, and now you’re back to square one - putting the house back on the market and going through the sale cycle.
  • Market Might Go Up: Once you sign the lease option agreement, you’re locked into that closing price. This can be hurtful if the home value appreciates before the sale of the home. Your home value may increase 10% within the timeframe of the lease option agreement, leaving a substantial lost profit potential on the table.
  • Market Might Go Down: The exact opposite also presents a risk. If the market goes down and the renter backs out of the deal, you missed your opportunity to sell at a market high.
  • Renter Could Discover Home Issues: Although some of this can be avoided if the renter does a proper home appraisal and inspection, there may be major issues with your home that the renter uncovers. This could jeopardize the deal, depending on how the agreement is worded.

Find Your Path to Homeownership

Buying a home is a serious matter, you should treat it as such! If you’re looking into a lease option, or rent to own, you should treat the transaction as though you were buying the house right from the start. That means do your diligence on the home, get a proper appraisal, home inspection, and work with a lawyer on structuring the agreement between you and the current homeowner.

There are numerous reasons why these lease agreements may be for you. Perhaps you’re looking to save more money for a larger down payment, need to raise your credit score, or have to pay off some debt before you’re approved for a mortgage. Whatever your motive, a lease agreement is a great tool to leverage.

As the seller of the home, you too have a lot to consider. You’ll be able to charge a rent premium, and may even be able to sell your home for a slightly higher price than market value. The financial upside is what many people find most attractive about these deals.

However, wherever there is a reward, there is a risk. You’ll need to consider all the downside possibilities before ultimately deciding if you’re willing to enter into one of these agreements.

 

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All material is presented for informational and educational purposes only and should not be construed as individual financial, investment, or legal advice or instruction. ZeroMortgage does not guarantee the quality, accuracy, completeness or timelines of the information in this publication. While efforts are made to verify the information provided, the information should not be assumed to be error free. Some information in the publication may have been provided by third parties and has not necessarily been verified by ZeroMortgage. ZeroMortgage, its affiliates, and subsidiaries do not assume any liability for the information contained herein, be it direct, indirect, consequential, special, or exemplary, or other damages whatsoever and howsoever caused, arising out of or in connection with the use of this publication or in reliance on the information, including any personal or pecuniary loss, whether the action is in contract, tort (including negligence) or other tortious action. ZeroMortgage does not provide tax advice. Please contact your tax adviser for any tax related questions.

This page last updated: March 23, 2022